the visible hand of china in latin america pdf

Drafts and different elements of the book were presented in meetings and conferences held at Georgetown University, October 2004, Columbia University October 2004, The World Bank October

The Visible Hand

of China in Latin

America (—

Edited by Javier Santiso

Í Development Centre Studies

The Visible Hand

of China in Latin America

Edited by Javier Santiso

Development Centre Studies

The Visible Hand

of China in Latin America

by Javier Santiso

orcn (@

DEVELOPMENT CENTRE OF THE ORGANISATION

FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

ORGANISATION FOR ECONOMIC CO-OPERATION

‘commen problems, identify good practice and work to co-ordinate domestic and international polices,

‘The OECD member countries ate: Australia, Austria, Belgium, Canada, the (Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, ttaly,Fapan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand,

"Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States, The Commission of the European Communities takes partin the work of the OECD

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THE DEVELOPMENT CENTRE

‘The Development Centre of the Organisation for EconomicCo-operation

‘and Development was established by decision of the OECD Council on

23 October 1962 and comprises 22 member countries of the OECD: Austria, Belgium, the Czech Republic, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Korea, Luxembourg, Mexico, the Netherlands, Norway, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey and the United Kingdom

as well as Brazil since March 1994, Chile since November 1998, India since February 2001, Romania since October 2004, Thailand since March 2005 and South Arica since May 2006, The Commission of the European Communities also takes part in the Centre's Governing Board

‘The Development Centre, whose membership is open to both OECD and non-OECD countries, occupies a unique place within the OECD and in the international community Members finance the Centre and serve on its Governing Board, which sets the biennial work programme and oversees its implementation

‘The Centre links OECD members with developing and emerging

‘economies and fosters debate and discussion to seek creative policy solutions to-emerging global issues and development challenges Participants in Centre

‘events are invited in their personal capacity

A small core of staff works with experts and institutions from the OECD and partner countries to fulfil the Centre's work programme, The results are discussed

in informal expert and policy dialogue meetings, and are published in a range of high-quality products forthe research and policy communities The Centre's Stly Series presents in-depth analyses of major development issues Policy Bros and Policy insights summarise major conclusions for policy makers; Working Pyyvrs deal

‘with the more technical aspects of the Centre's work,

For an overview of the Centro’ activities, please see www oecel orgider

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ble Hand of China in Lain Ameria

Acknowledgements

The Development Contre would like to thank participants in its March

2006 “Asian Drivers" conference for their valuable insights and comments on

‘many of the issues raised in this volume

Drafts and different elements of the book were presented in meetings and conferences held at Georgetown University, (October 2004), Columbia University (October 2004), The World Bank (October 2004, May 2005 and June 2006), LACEA (November 2004), CAF (November 2004), OECD Development Centre (January 2005), IDB (April 2005), Casa América in Madrid (June 2006),

‘Swiss Latin American Chamber of Commerce in Zurich (June 2006), Standard Chartered in London (une 2006), Suez Group in Paris (September 2006), Exane BNP Paribas in Geneva (September 2006), French Ministry of Foreign Affairs (October 2006) and the European Commission in Brussels (November 2006),

‘The authors and editors also extend their appreciation to participants in these events whose comments represented valuable contributions to the final form

of the book Finally, former Deputy Secretary General of the OECD Robert Cornellis to be thanked for his excellent editing of the volume

This study was made possible by the generous support of the Spanish, Ministries of Finance and Economy and of Foreign Affairs for activities at the OECD Development Centre related to Latin America

Preface

‘This detailed study of the impact of China on Latin America is part of a major Development Centre initiative that culminated in a March 2006 conference, The event brought together experts from OECD and non-OECD countries to discuss the impacts of the Asian Drivers on other developing

‘economies in Africa, Asia and Latin America

China has beena powerful global player in the past, as detailed by Angus Maddison in earlier work for the OECD Development Centre’, contributing {as much as nearly a third of world GDP as late as the beginning of the 19th century Its recovery over the past decade has been spectacular, creating, both opportunities and challenges for many other countries, most notably developing countriesand emerging economies, For Latin America, China looks

‘more like a “trade angel’, as it provides an outlet for commodities from the rogion China‘s trade impact on Latin America is, thus, positive; directly, through a boom of exports, and indirectly, through better terms of trade The rise of China is also a challenge for Latin American countries If they are to keep building on their comparative advantage, reforms must continue, particularly in the area of infrastructure

The following chapters present detailed evidence of the positive and negative trade and financial impacts of the rise of China on Latin America, demonstrating that this is probably one of the rogions in the world to benefit _most, Some of the authors concentrate theit analysis on the trade impacts while others deal with foreign directinvestment lof them note that China represents

1 See, OECD Development Centre Studies:

Mavoso, A (2008), The Weld Economy: Historical Statistics, Paris

Mavoson, A (2001, The World Eeonomy: A Millennial Perspective, Paris

Mavosos, A (199), Chinese Econone Performance the Long Rum, Pais

sible Hand of China

‘@ unique opportunity for Latin America to build on the traditional endowments,

of the region The major policy issue will be how to continue to capitalise on the Chinese windfall while avoiding the risk of being pushed into a raw

‘materials comer, instead of deepening integration into the global value chain, Beyond trade, what is also emerging is a notable shift in global patterns

‘of economicinterdependence, Economic ties between Latin America and Asia were already strong, especially with Japan and Korea The emergence of China —and India~ extends and deepens dramatically these ties Latin America is looking more and more towards Asia; emerging Asia seeks resourcesand new markets in Latin Ameria For Europe and the United States, thisis also a wake-up cal

Louka T Katseli Director, OECD Development Centre

March 2007

Chins: A Helping Hand for Latin America?

Introduction China: A Helping Hand for Latin America?

by Javier Santiso

China's economic boom represents a major global change Over the last few years, China has expanded by leaps and bounds and become both a threat

to and an opportunity for emerging markets Its growing demand for raw

‘materialsisat the same timea bonanza and a challenge for developing countries The Chinese boom brings a positive windfall boosting trade exports of countries whose endowments are commodity related, This appetite for raw

‘materials is, however, also contributing to nominal and real exchange rate appreciations in most Latin American countries leading to lower competitiveness in manufacturing sectors At the same time, China has cemerged as a major exporter at both the labour-intensive, low technology and, increasingly, at the knowledge-intensive, higher technology end of the product spectrum, It is presenting challenges to most developing countries, and particularly other global trade champions like Mexico in nearly all sectors, from textiles to most industrial products with higher value-added

Should Latin America fear the emergence of this new global economic player? This question is the basis of Eduardo Lora’s Chapter 1, which compares the respective strengths of the Chinese economy relative to Latin America; these or such strengths include size, macroeconomic stability, abundant low- cost labour, rapidly expanding physical infrastructure, ability to innovate and

‘massive ratios of investments and savings This is also the central question posed by all other contributing expertsand scholars from leading international institutions and academia, including the Inter-American Development Bank, the Asian Development Bank, the OECD Development Centre, the Central Bank

The Vilble Hand of China in latin america

cof Spain, the Central Bank of Chile, Oxford University, and private banks such

as BBVA (Banco Bilbao Vizcaya Argentaria), one ofthe leading European banks that is also the major financial player in Latin America

CChina’s trade impact on Latin America is mostly positive, both directly, through an export boom, and indirectly, through better terms of trade, China Jooks like a “trade angel” and a “helping hand” as well as being an outlet for commodities from the region With galloping GDP growth and a scarcity of arable land, China's appelite for natural resources and farm products seems

‘good news for Latin America With $50 billion worth of trade and investments,

in Latin America in 2005, China is already a major partner

To analyse China's trade impact on the rest of the world, Blizquez, Rodriguez and Santiso look at the export and import structure of the country

in Chapter 2, They use a database of 620 different goods and build two indexes

of trade competition in the US market in order to compare the Chinese impact lover the period 1998-2004 on 34 different economies, of which 15 are in Latin America This shows that Venezuela, Bolivia and Chile are those with the lowest indexes among the 34 and thus, those that suffer least from Chinese trade

‘competition Brazil, Colombia and Peru are in an intermediate position The countries that are most exposed to Chinese competition in the United States are Central American countries and Mexico

Sanjaya Lall and John Weiss reach similar conclusions in Chapter 3, which analyses and compares China's and Latin America's export performance and specialisation patterns in the world as a whole, induding the United States, the main market for both, They show that the trade structure of most Latin

‘American countries is generally more complementary than competitive with CChina’s Lall and Weiss join the earlier authors, however, in underlining the point that if China represents a unique trade opportunity for Latin America, it

‘may nonetheless pose a serious threat to its long-term development: heavy reliance on resource-based products is not conducive to technological upgrading and diversification A potential revaluation of the renminbi could enhance competitiveness of Latin American productsin US markets, as stressed

by Lopez-Cérdova etal in Chapter 4 This issue is likely to remain a major structural challenge,

China's emergence is a wake-up call for Latin America, Countries like Mexico will have to boost reforms in order to remain in the competitiveness race Labour costs will clearly no longer offer a competitive advantage, at least

in the medium term, A better way to deal with the Chinese challenge will be

to push ahead the agenda of reforms, particularly in the area of infrastructures

“Chinh: A Helping Hand for Latin Amedeo For Mexico and Central America, proximity to the United States is a major strategic asset on which to capitalise The best way of doing this is to improve the efficiency of roads, ports, railwaysand airportsin order to lower transaction and transportation costs

For other Latin American countries, China is likely to remain a trade angel Not surprisingly, the countries that mainly export raw materials face ower competition This is only to be expected, bearing in mind that China is a net importer of such commodities In 2003, Chinese imports of nickel doubled, its copper imports grew by 15 per cent, oil by 30 per cent and soy beans by 70 per cent China has become the world’s leading consumer of copper, zinc, platinum, iron and steel,

‘Most Latin American countries are thus witnessing a tremendous increase

in their exports, The region's commodity-specialising exporters are well able 10 fulfil the needs of growing Chinese demand contributing 47 per cent of world exports of soy beans and 40 per cent of world exports of copper Latin American

‘exports towards China jumped by impressive numbers in nominal terms, From

2010 to 2003, Brazil's exports increased by 500 per cent, Argentina's by 360 per

‘cent and Chile’ by 240 per cont Even Mexico, a global trader in manufactures, saw its exports towards China increasing by 1000 per cent over the period,

China has become Brazil's second and fastest-growing export market but these exports are concentrated on five commodities that account for 75 per cent of Brazil's exports to China, Soy beans are the major commodity exported towards China, both for Brazil and Argentina For Chile and Peru, the bulk of exports towards China are concentrated on a single commodity, namely copper Despite concentration in a small basket of commodities, China's strong demand for raw materialsis, nevertheless, good news for Latin America From

2000 to 2005, China represented nearly 40 per cent ofthe total growth in world oil demand China's growing thirst for oil has been driving oil prices up and boosting trade surpluses of oil exporters such as Venezuela, Ecuador and Colombia The surge of Chinese imports of copper aver the last few years also

‘caused prices to rise and has been a boost for Chile and Peru, two other

‘economies that have registered record trade surpluses in 2004 and 2005,

China is not only a major trade partner for Latin America During the coming decade, it might well offer a helping and visible hand in terms of capital flows China does not seem to compete with Latin America for foreign direct investment It attracted as much FDI as the whole of Latin America lover the past years, but this does not seem to have been at the expense of Latin American countries As underlined by Alicia Garcfa-Herrero and Daniel

The Vilble Hand of China in latin america

Santabrbara in Chapter 5, there isno substitution from Latin Americaninward, FDI to China for the period analysed, namely from 1984 to 2001 Flowever,

‘when assessing the impact country by country and for the more recent period 11995-2001, the picture changes a little as China's inward FDI appears to have hampered that of some countries in the region, namely Mexico and Colombia Infact instead of fearing increasing competition from China for capturing FDI, Latin America may once again be well placed to attract Chinese interests

‘The region has a surplus commodity endowment that boosts synergies with CChina’s need and strategy to secure food and energy imports inorder to avoid shortages Chinese investments can and will be channelled not only in agri- business and commodity-related industries but also in infrastructures, roads, and ports

{In 2003, China's outward investment more than doubled in the course of

4 year (although itis still ata low level) and Latin America received one third

of world Chinese FDI The following year, nearly 50 per cent of Chinose FDI went to Latin America (16 per cent in 2005, of a total record of 7 billion of dollars invested overseas) The need to secure food and commodities is boosting FDI through strategic international partnerships In Mexico, China

is already setting up manufacturing companies and Chinese interests in Argentina's railway construction or agvibusiness-related projects are also on the rise Some of the biggest investments carried out abroad by Chinese

‘companies are already located in Latin America, namely in Brazil inthe steet and iron industry: In 2004, The Chinese state oil company Sinopec invested

$1 billion in ajoint venture with Petrobras forthe construction ofa gas pipeline linking south to northeast Brazil Other deals the Chinese have recently signed included iron ore shipments from Companhia Vale do Rio Doce (CVRD), one

of the world’s largest mining concerns, for Shanghai's famous Baoshan Stee! Mill In2005, Codelco, the Chilean copper giant signed an historic trade contract,

«with Chinese Minmetals

of growth, Until the 1980, the United States was the major trade partner of

“Chinh: A Helping Hand for Latin Amedeo the region During the 1990s, the boom in European investments provided a second engine of growth Today, inthis new decade and century, the emergence

of China, and above all Asia, is proving to be a third engine of growth for Latin America The Asian demand for commodities offers Latin America a

‘unique historic opportunity but for that the region will have to do more than simply surfing the wave

Even for those Latin American surfers that are benefiting from the Chinese

‘windfall, the major policy issue will be not only to capitalise on this bonanze

‘but above all to avoid the risk of being pushed into a raw materials corner and

40 romain integrated into the value chain of global production

Beyond the trade and financial impacts of China on Latin America,

‘hore might be a more subtle effect that could be labelled a “cognitive impact” China symbolises a success story, catching the attention of development economists, policy makers and firm managers in both developed and developing countries If the Chineso success story is striking, it is because this development trajectory testifies to the impressive economic pragmatism

of China's policy makers who apply marketfriendly policies, driven by the state, to promote reforms and productive restructuring This capitalist bricolage is unique, even ifit is similar to previous Asian experiences, notably

‘those of Japan, Singapore or Malaysia What remains different is that in the

‘ease of China itis driven by a Communist Party

‘The political economy of pragmatism is more prevalent today around the world than was the case a few years ago Without any reference to a

‘macro paradigm or a text-book model, China pushed ahead with its own trajectory There were no “Chicago Boys”, or “Money Doctors” landing in Beijing to advise what to do or not to do, In Latin America, this pragmatism has also been at work in countries like Chile, Mexico and Brazil (Santiso, 2006) All in all, these experiences, though each very different and unique, are pointing to the fact that there is no magic formula or magic key that

‘opens the box of development

‘he Visible Hand of Ching ty atin America

Bibliography

Drvusy, R, A ESTEVADEORDAL AND A Ronstoucz (2006) (eds), The Emergence of China (Opportunites nd Challenges fr Latin Amerie ed He Caribbean, Harward University Press, David Rockefeller Centre and Inter-American Development Bank: Cambridge, Mass

‘This chapter compares growth conditions in China and Latin America to assess fears that China will displace Latin America in the coming decades

CChina’s strengths include the size of the economy, macroeconomic stability,

abundant low-cost labout, the rapid expansion of physical infrastructure

and tho ability to innovate Its weaknesses stem from insufficient separation, between market and state They involve poor corporate governance, a fragile financial system and misallocation of savings Both regions also share important weaknesses The rule of law is weak, corruption is endemic and

{education is both poor and very poorly distributed

Introduction

China has been the world’s fastest-growing economy for the last three decades Since economic reforms started in 1978, the economy has shown average real growth of 9.4 per cent per year Eliminating the most obvious factors of overestimation that the official statistics may contain, Alwyn Young, (2003) has estimated this growth as L7 percentage points lower, with annual per capita income growth at 6.1 per cent instead of the offically reported 78 per

‘cent’ Even with Chinese growth rates two or three points lower than officially reported, however, Latin America does not shine in comparison Its average annual growth rate since 1978 has been only 2.3 per cent, While per capita income in China increased more than sevenfold between 1978 and 2005 Ian: oreze4az7661

according to official figures (or fourfold with Young's adjustments), Latin

‘America reported an average increase of only 20 per cent While manufacturing, has ed in China with average growth rates of over 12 per cent, the performance

of the Latin American manufacturing sector has been disappointing too; its annual average growth was only 0.3 per cent in the 1980s and 2.5 per cent in the 1990s

Since China joined the World Trade Organisation in December 2001, these divergences have attracted growing attention because of fears that competition from Chinese products was having a devastating effect on clothing maguilas, clectronics products industries and many other industrial products from thousands of companies around Latin America Competition from China may bbe one reason for the decline in foreign direct investment (FDI) to Latin America (Figure 1.1) for a discussion see Chapter 5 in this book Mexico’s FDI inflows {ell from $26.6 billion in 2001 to $11 billion in 2003, and 960 firms left the country with an estimated loss of over 300 000 jobs (254 000 in the maguilas alone)’ Although these trends partly reversed in 2004, as FDI rose to

$14.4 billion with an estimated increase of 70 000 maguiladora jobs, fears

‘mounted again when FDI fell back to $113 billion in 2005 For Latin America

as a whole, although FDI climbed from a low of $32.6 billion in 2003 to

$47.3 billion in 2005, it remains substantially below its 1999 peak of

‘This chapter attempts to assess whether fears that China will displace Latin [America in the coming decades are well grounded Several studies have tackled this issue from a microeconomic perspective, comparing factor endowments, export structures or key cost components such as labour oF transportation costs

‘This one takes a different approach It compares China and Latin America in terms of growth performance as well as their ability to attract foreign direct investment While this approach does not lend itself to empirical testing, it providesa more comprehensive and balanced view of China’seconomy, which,

‘may be useful both to prospective investors and to practitioners and analysts, especially those already familiar with Latin America

The chapter argues that China's strengths relative to Latin America derive from the size of the economy, its macroeconomic stability, the abundance of low-cost labour, the rapid expansion ofits physical infrastructure and its ability

to innovate China's main weaknesses are by-products ofthe lack of separation

‘between market and state This results in poor corporate governance, a fragile financial system and a tendency to misallocate savings, currently manifested throuigh excess investment in many sectors China also shares several deep deficiencies with Latin America In both regions, the rule of law is weak,

‘corruption is endemic and education is poor and very poorly distributed, Broadly based innovation is discouraged by the lack of respect for property rights and by norms and practices that inhibit competition In the medium term, both China's and Latin America’s ability to correct their institutional flaws will determine their capacity to achieve higher income levels and fully

to integrate into the world economy

in expanded markets and better export prices, especially for primary goods, Which are a very important source of external revenue for Latin America It

also results in higher world savings, which help to finance countries with, external deficits, as is usually the case for Latin American countries and the United States The enormous US current-account deficit, which benefits Latin

‘America, can be sustained only by direct external financing from China and other Asian countries Consequently, underscoring China's strengthsin relation

to Latin America is useful for understanding why China is more successful, but it does not mean that conditions in Latin America would be better if China lacked these strengths,

Size

China is the sixth largest economy in the world At the growth rates it has enjoyed in recent decades it appears set to become the largest in less than 40 years, based on GDP valued at market exchange rates, With GDP valued at PPP rates, however, it already is the world’s second largest economy; it will overtake the United States in less than a decade if both countries maintain their current growth rates China also has an impressive importance in world trade, because it is more open than other countries,

‘more notably India, Brazil and the United States These countries’ exports and imports are no more than 25 per cent of GDP, while China's trade represents half of its GDP at market value’

Size generates advantages because it helps attract foreign investment to exploit the domestic market and produce for export, tapping, the enormous supply of labour that is China's most abundant resource", In such a huge

‘economy, companies can exploit economies of scale in production, transport and marketing that are decisive for penetrating international markets (Hummels, 2004) The large Chinese cities also offer opportunities to exploit economies of agglomeration, facilitating the formation of company clusters that complement and compete with each other This factor is crucial for developing and exploiting skilled labour resources and expanding sectors that depend on knowledge and innovation In China, however, other factors — such as the special status of state companies and the poor innovation climate

— provent companies from fully using these advantages

Sustained Growth

The best-known international competitiveness indicator is the Growth Competitiveness Index published annually by the World Economie Forum Its latest edition ranks China 54th among 125 countries (World Economic

‘method, the index tends to relate closely to countries’ income levels, which

‘means that richer countries always tend to occupy higher positions After controlling for income, however, China occupies an extraordinary relative position In Latin America, only Chile holds a place significantly higher than that predicted by its income level Countries that have such good positions tend to grow more rapidly later — and conversely for countries with poor positions", The indicator thus providesa good barometer of the quality of the environment for the future development of productive activity, because it incorporates factors crucial for economic growth, such as macroeconomic stability, the quality of institutions and the environment for technological improvements and innovation

‘expected for China’s income level

Underlying the positive macroeconomic indicators are the level and stability of economic growth and the good risk ratings that international analysts assign to China on the basis of is growth record, low inflation rates, low levels of government debt and the soundness ofits international reserves and external balance Naturally, such measurement involvesa certain amount

of circularity, Because China has had rapid and stable growth in the past, it receives good risk ratings that maintain the expectation of sustained growth:

‘this becomes a self-fulfilling prophecy The opposite is the case for most Latin American countries These self-fulfilling expectations, however, ate a double- edged sword: although they provide time to resolve macroeconomic or structural imbalances, they also tempt countries to ignore them This could be the case for the Chinese financial system, addressed further below It also applies to the repressed appreciation ofthe renminbi, whereby an excess supply

of foreign exchange has given rise to a gargantuan accumulation of international reserves In 2005 alone, China's international reserves increased

by $209 billion, reaching nearly $819 billion (or 42.8 per cent of GDP at current prices)" This represents a “War chest” that, along with other features of the Chinese economy, offers protection against the risks of a sudden stop in capital

Cheap and Abundant Manpower

A large domestic market and abundant cheap labour is China's most evident advantage in attracting foreign investment and exporting,

‘manufactures The average wage in manufacturing was only $141 a month in

2004 lower than the current minimum wage in most Latin American countries (Figure 1.2) In 1990, the average wage was $36 a month, implying a 10.2 per cent average annual nominal increase between 1990-2004 This does not differ substantially from the economic growth rate ofthe period (9.7 per cent) or the

‘growth rate of workers’ productivity in the overall economy (85 per cent)

‘That industrial wages have risen at the rate of economic growth does not imply restrictions on the total labour supply According to offical sources",

‘the working-age population totalled 897 million in 2003, 85 per cent of which effectively participated in the labour market This is one of the highest ratesin the world, possibly thanks to the level of participation of women in the labour market and the low fertility rates promoted by the communist system Although employment in the overall economy has grown by only 2.5 per cent annually since 1980 (and by only 1.1 per cent since 1990), the most dynamic sectors have not suffered from labour shortages because there is redundant labour in agriculture and the state companies Employment outside these two sectors grew at 7.9 per cent annually in 1980-2001 and at 5.3 per cent in 1990-

2001 (Brooks and Tao, 2003) This process isfar from exhausted The inefficient sectorshave an estimated 160 million surplus workers, and in the next quarter century the rural population could decline by 300 million people (Wolf, 2003) Despite its importance, a multitude of restrictions that are only gradually being relaxed, constrain rural-urban migration, The most important traditional constraint is the system of household registration (hukor), which is required

in order to remain in the cities and have access to jobs and basic services of education, healthcare and social security ® Migration has also been limited by

‘emigrants’ fear of losing land ownership rights in their rural areas of origin and by the stricter limit on the permitted number of births per household imposed on city residents Since 2001, people with stable employment and

3A Sät:^V

residents have been extended permission to register in over 20.000 small towns and cities without fear of losing land rights Several taxes on migrants have been dismantled, Severe restrictions persist in most large cities however and some time will pass before the 2001 reform is fully applied even in smaller cities (rooks and Tao, 2003),

“The movement of labour into more efficient sectors has been the major source of total factor productivity (TFP) inereases, which have contributed

‘around 3 per cent per year to GDP growth over the past two decades Table 1.1) Based on the differences in average labour productivity between agriculture,

‘manufacturing and the service sector, the OECD has calculated that about fone quarter of the increase in productivity (and one fifth of the change in income per capita) since 1983 has come from the reallocation of labour Yet its actual contribution could be higher, since the productivity of the marginal

‘worker who leaves agriculture is estimated at one sixteenth that of the marginal urban worker Although the contribution of sectoral change to GDP growth Weakened in the second half of the 1990s, it has picked up since 2000 and is certainly far from finished (OECD, 2003)

ofc

Sectoral change 1S on

Latin America has also witnessed significant rural-urban migration In

1980, half the population of the typical country of the region lived in the countryside; currently only one third does so", Yet this migration has not resulted in appreciable increases in productivity In contrast with China, productivity has had a negative contribution to Latin American growth, especially in the 1980s, but also more recently The most important excey

is Chile, where it has added 1.8 percentage points to average growth in the last 20 years (Loayza et ul, 2002)" The shift of employment from country to city has not helped much because of the modest rural-urban labour- productivity gap (typically 30 per cent, sce IDB, 1998) and because the sectors

\with the highest productivity in the cities have generated few jobs Asa result, Latin America, unlike China, has not succeeded in using the surplus labour from its inefficient sectors

(One of the reasons for this difference, although clearly not the only one,

is the extremely protectionist nature of Latin American labour legislation in

‘comparison with China's or, more accurately, with that in China's dynamic sectors Latin America regulates in considerable detail the length of the working, day as well as vacations and other worker benefits Laws further govern conditions for the dismissal of workers and the compensation (typically fairly high) that employers must pay when they cannot demonstrate compliance

‘with them China has no similar national labour code The traditional “iron rice bow!” system made state companies responsible for the obligations of labour protection and social security, which they independently granted to their workers as a mechanism for maintaining discipline in exchange for life- long job security These benefits were very generous in other respects too, and they remain an unresolved problem for many companies, This traditional system has led to demands for improvements in pay, non-wage benefits and hiring and dismissal conditions, which vary from region to region and are partly negotiable between private companies and the local authorities and/or the labour unions Consequently, current labour legislation for private

‘companies provides less protection of employment conditions and job security

than typical laws in Latin America, and its application is also much less predictable (OECD, 2003)

Although China has an enormous reserve of rural labour that could sustain growth during the coming decades, the longer-term prospect is hardly encouraging because of the demographic trends stemming from the one-child policy For every person over 60 years of age, there are currently some six of working age This ratio has held for more or less half a century, but it is beginning to fall By 2040, China will have only two working-age people for every person over 60 Latin America starts from a younger demographic base,

so that until 2040 i will keep the six-to-one ratio that China now enjoys (United Nations, 2002) China will then confront an enormous social burden that will require it to raise taxes quite far above the levels typical of Latin America,

‘The Physical Infrastructure Boom

Until 20 years ago China’s transport, communications and energy infrastructure was very much below the standard of Latin America’s most developed countries Although serious deficiencies persist and itis difficult

to meet the fast-growing demand for infrastructure services of all kinds, recent improvements have been truly noteworthy, especially in roads, ports, telecommunications and electricity, which will likely contribute to sustaining

‘growth, Because of the privatisation process, many Latin American countries, hhave also made good progress, although concentrated largely in the areas of telecommunications and, to a lesser extent, electricity and ports In China, investment in infrastructure has grown much faster than the economy as a whole (rising from 2:3 per cent of GDP in the early eighties to around 9 per cent in 1998-2002) This has not been the case in Latin America, where investment in areas that have not attracted private sector attention as been neglected Total (public and private) spending in infrastructure in Latin [America is currently less than 2 per cent ofits GDP, down from 37 per cent during 1980-85

China's railways, the backbone of the transport system, have received large investments in recent years, including a second line from Beijing, to Kowloon (Hong Kong, China) and the extension of the network to distant areas such as Kashgar in Xinjiang and to Tibet The total length of railways in

‘operation reached 61 000 km in 2004, up from 53 400 km in 1990 High-speed rail lines will reduce the travel time between Shanghai and Beijing {rom

13 hours to less than five, as part of an ambitious scheme to construct 5 400 km

of high-speed rail track between 2006 and the end of the decade Progress on roads has been even more remarkable, Since the early 1990s, inter-provincial expressways inereased from zero to 34 300 km in 2004, and the total length of highways rose to 1.9 million km Port facilities have also improved appreciably

in recent years China has 200 ports, some of them among the world’s ten largest, but many are too shallow for large container ships The most important

‘current project is the expansion of Shanghai's port, the first phase of which

‘was inaugurated in late 2005, The whole project will take another 15 years

(335 million in 2004) than the United States It also has 312 million fixed telephone lines and 94 million Internet subscribers According, to the

‘government, the extension of the optical fibre network will bring broadband

‘multimedia access to all urban homes by 2010 (EIU, 2006; The Economist,

‘30 March 2006)

The Ability to Innovate

With its present low level of income, China will need over two decades

at current growth rates to reach half the income per capita (PPP) of the United States A small economy in this situation would use all ofthat time to continue exploiting external technological development China's size, however, imposes

‘the need to conquer increasingly sophisticated goods markets with ever-higher technological and innovative content, and this is exactly what China has done Supported by a massive inflow of FDI to its high-technology sectors, China has become the tap provider of electronic goods “China for the first time in

2004 surpassed America to export the most technology waresaround the world, according to new figures from the Organisation for Economic Co-operation and Development The crossover took place in 2004, when China exported

$3180 billion of computers, mobile phones and other digital stuff, exceeding

‘America’s international sales of $149 billion A year earlier, in 2003, China's technology exports had overtaken those of both the European Union and Japan.” (The Economist, 14 December 2005) The pace of innovation, as

‘measured by the number of patents, is also picking up China accounted for

1130 000 patent applications in 2004 (the most recent year for which figures are available) That makesit number 5 globally, according to the World Intellectual Property Organization, a United Nations agency Although China was still far behind Japan (with 450 000 patents in 2004) and the United States (with

403 000), its 2004 patent applications were six times the number in 1995,

‘government has long recognised that planners do nat have the technical Capabilities to evaluate new technology, and it has therefore encouraged

research institutions to commercialise their research products Industrial policies also support innovation in software and integrated circuits with research funding, preferential procurement policies and tax exemptions, Crucially, both foreigr-invested and domestic firms enjoy preferences Policies

‘generally apply across the board, with no attempt to "pick winners” Research incentives seem to have paid off handsomely According toa 2000 R&D survey, enterprises now make some 60 per cent of China's R&D outlays The creation

of Chinese technology standardsas opposed to global ones recently has further encouraged innovation This gives Chinese firms a competitive advantage, because it delays the entry of foreign technology holders into the Chinese

‘market and gives Chinese firms bargaining power with foreign suppliers over technology and intellectual property This strategy has been instrumental in the development of some new digital technologies to the advantage of Chinese {and Chinese Taipei) firms, Despite or because of the failure of some earlier attempts, Latin American governments dismantled their incipient industrial policies in the 1990s and only now are starting to reconsider them

Nevertheless, the environment for innovation in China has several limitations, many of them similar to those found in most Latin American

‘countries, rksome procedures hinder starting new companies; access to credit

‘and capital markets is very limited; property rights are weakly protected; and

‘competition is restricted by geographical and infrastructure barriers that raise the cost of transport and by a multiplicity of local protection mechanisms for industries in the form of operating permits, requirements for use of local raw

‘materials, taxes and other restrictions (World Bank, 20032) This suggests that

it is time to look at the other side of the mountain,

China's Weaknesses

The lack of separation between the state and the market is the overriding,

‘weakness of the Chinese economy, The slate does not just simply interfere strongly in the decisions of other economic agents, asin Latin America before the wave of structural reforms of the last 20 years, but itis also the most important agent in domestic and international production as well as in

‘marketing decisions Infact, the state remains the main employer and the main

‘channel for the allocation of savings The lack of separation between the state {and the market extends to all aspects of economic activity and is aggravated because the state is not a cohesive, centralised entity but a thousand-headed

hydra that operates at all levels It becomes evident in poor corporate

‘governance, major risks in the financial sector and the use of a variety 0F controls thal favour state-owned enterprises and reduce market discipline Overinvestment in many sectors is a current manifestation of inadequate

‘market discipline

State-Owned Enterprises and Corporate Governance

In China itis not possible to dofine precisely the dividing line between ppublicand private property The introduction of non-state forms of production began with the system of rural responsibility that led to the privatisation of agriculture (although not rural land, which remains under state or community control) and to the proliferation of “town and village enterprises, small and

‘medium-sized light manufacturing firms The success of this experiment led the government in 1984 to initiate reforms in state industrial companies, which are continuing The objective of the process was to improve efficiency in the State sector while preserving the state ownership of these companies In the process, the Chinese state has experimented with an enormous variety of forms

Of state, collective, foreign and individual ownership, all of which currently covxist around a nucleus of large state companies, which in 2001 accounted for 47:3 per cent of investment in the fixed assets of the economy and 44 per cent of industrial production Even by then, however, the number of state

‘companies had fallen by two-thirds, to 34 500 from 87 900 in 1995, asa result

of the “grab the big and let the small go" strategy announced by Zhu Ron;

in 1998 (China Economic Quorterly, 2003, pp 20) Asa result, the share in value added of state-and collectively controlled firms in the business sector declined from 4655 per cent in 1998 to 36,7 per cent in 2003 (OECD, 2005)

The last step in this reform process was the establishment in 2003 of the State-owned Assets Supervision and Administration Commission (SSAC), which currently exercises direct control over 169 large state companies,

‘guaranteeing thatthe three largest firms in the main economic sectors remain, state-owned and that 30 to 50 per cent of them will be “national champions” (or “globally competitive” multinationals by 2010 This does not mean that the other state companies will necessarily be privatised, but rather that they will have to support themselves An explicit reform objective is to expand state control capacity through the laws and regulations on ownership and corporate governance The preferred way to restructure state companies throughout China is to set up an operating company to hold the productive assets This company is in turn owned by a state-owned holding company These holding

28

companies exercise control and assume responsibility for the social obligations,

‘that all state companies had in the past (education, housing, social security) Many state-controlled operating companies offer shares on the stock market,

‘a mechanism that in practice also contributes to expanding state control bbecauise the minority shareholders lack the rights common in other countries Inaddition, the reliability of accounting systems and external auditing is very poor, and the practice of selling shares among holders to manipulate their value is rampant, according to the international indicators of the World Economic Forum Moreover, the Corporation Law has been designed to facilitate the corporatisation of state companies, impose earnings reinvestment requirements and restrict the composition of boards of directors in ways detrimental to independent control of private companies”,

Because state-owned enterprises are structured to respond more to the political and strategic objectives of the Communist Party than to market signals,

it is not surprising that investment decisions, often flawed, lead to overinvestment Foreign firms are also encouraged, especially by local governments through a variety of incentives, to invest in sectors that may bring political recognition Excess capacity is rampant in steel, aluminium and cement, sectors under the control of the government, but it is also noticeable in automobiles, electronics, communications equipment and many other sectors with high foreign participation The major risk caused by overinvestment is that many state-owned firms may find it impossible to honour their financial commitments to the already overextended official banks The Financial Sys

in circulation expanded 184.9 per cent of GDP (EIU, 2006) — in practice access

to credit is restricted to state-controlled companies and the largest private sector firms Small and medium-sized businesses, which account for more than half of GDP, receive less than 10 per cent of total bank loans (OECD, 2005) In the opinion of businesses consulted by the World Economic Forum, China restricts access to credit more than do most Latin American countries,

‘where typical ratios are 30 per cent of GDP Because equity-market access also tilts in favour of incumbent (especially state-owned) firms, efficient methods

to allocate savings are clearly wanting

ISBN: 9786264027001

‘The banking system is dominated by four major state banks originally oriented to separate sectors: the Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China The People's Bank of China operates as the central bank (and until recently as regulator of the banking system), and there are many state-owned commercial banks, most of them regional Until 2003, only one private bank other than branches of foreign banks could offer international services Since

2003, foreign banks have been able to provide services in local currency’ to Chinese companies, and at the end of 2006 they were authorised to offer services to individuals Pursuant to commitments made by China on its accession to the World Trade Organization, the geographical restrictions on the operation of foreign banks were finally eliminated in 2006

Those limitations contrast with the freedom of entry and operation that has existed in most Latin American financial systems since the reforms of the 1990s, The main weakness of the Chinese financial system does not relate to these restrictions, however, but to the poor quality of regulation and supervision According to official figures for the end of 2002, the non- performing, debts of the four major state banks equalled 26 per cent of their

‘assets By September 2005, the non-performing loan ratio of the big four banks hhad declined to 10.1 per cent (EIU, 2005), due to policies adopted to clean their portfolios The real bad-debt ratio is thought to be higher, however, because of the practice of refinancing financially troubled state companies at interest rates controlled by the governmer

“The government has taken several measures to deal with the problems

ff the major banks In 1998 it gave them a $33 billion capital injection and transferred their bad debts to asset-management corporations for liquidation,

In 2003, the Chinese Banking Regulation Commission was established and,

in January 2004, a new capital injection of $45 billion went to two of the four largest state banks (Bank of China and China Construction Bank), which raised their capital to risk-weighted assets ratios from 7 per cent to 16 per cent (the international standard is 8 per cent) In 2005, a further $15 billion was injected into the Industrial and Commercial Bank of China and, in late

2005, the China Construction Bank became listed in Hong Kong, China and raised $8 billion from international investors In 2006, the Bank of China and the Industry and Commerce Bank of China went public ICBC public offering has become the largest in world history (around §22 billion) and its

‘market capitalisation could be around $130 billion However, banks will likely remain under central government control and their management will stay exposed to political influences

Many Latin American countries have experienced banking crises in the last 20 years, which have forced them to strengthen their systems of supervision and prudential regulation, raising them above levels current in China, Needless

to say, the macroeconomic volatility characteristic of Latin American countries isa source of vulnerability that China has not had to face, at least so far Yet ample evidence shows that financial liberalisations often turn sour in countries that lack adequate institutional infrastructure, because provious systems of interest-rate controls and directed credit may have created weak bank portfolios and failed to promote good “credit cultures” (Caprio and Hanson, 201) Such concerns fully apply to China Research on financial crises has also shown that when basic institutions that govern credit markets are flawed (ie when the rule of law is weak, creditors are unprotected and regulation is deficient) liberalisation increases the likelihood of a crisis (Demirgiic-Kunt and Detragiache, 1998; Arteta etal, 2001) Thus, even as current conditions in the financial sector pose a threat to Chinese stability, reform and eventual liberalisation will not be risk-free either

Given the difficulties of reforming the financial sector, equity-market liberalisation could in principle make a major difference in China More financially developed countries experience larger than average boosts from equity-market liberalisation, which suggests that China could oblainan important benefit gain, however, this effect tends to be muted in countries ike China with poor legal systems and weak investor protection (Bekaert eta, 2004)

‘The Trade Regime and International Transactions

Like Latin America, China has drastically cut tariffs and eliminated most restrictions on imports in the last 20 years The average tariff rate fell from 48.3 per cont in 1985 to 12,7 per cent in 2002, a drop slightly slower than in Latin America but similar in scope (Yang, 2003) Shortly after Latin America did s0, China unified its exchange market in 1994, and in 1996 it eliminated

‘the main restrictions on foreign-exchange trading associated with international trade In other respects, however, international goods and capital transactions remain subject to restrictions that do not exist in Latin America Only authorised companies may engage in international trade transactions Until

2005, regulations prevented privately owned firms from entering a number of sectors, such as infrastructure, public utilities and financial services All incoming capital is deposited in a special account, and payments or transfers against these accounts require approval from the State Administration of Foreign Exchange (SAFE) Until early 2006, foreigners could invest only in

B shares, which do not have the same rights as regular A shares New rules

allow some overseas investors to buy A shares as long as thay purchase at least 10 per cent stakes in listed companies and hold the stock for at least tree years All outward capital operations require authorisation from SAFE, and Chinese investment abroad is regulated and controlled by the China Securities Regulatory Commission (OECD, 2003) However, aso since 2006, some domestic investors (Qualified Domestic Institutional Investors, ODIIs) have been authorised to invest domestic funds in foreign markets Therefore, China is starting to experiment, in a various cautious way, with a gradual liberalisation of its capital markets

Misleading Indicators, Uncharted Paths

Given the lack of separation between the state and the market, one must interpret many economic indicators with caution

For example, financial depth does not reflect ease of access to credit because the state largely controls the credit system For the same reason, the {otal savings ratio is nota good indicator of the economy's investment capacity,

or atleast of investment capacity according to efficiency criteria According to offical statistics, China's saving and investment rates — at close 1030 per cent

of GDP (or 44 per cent and 40 per cent of GDP, respectively, to accord with recent revisions to 2004 GDP) — are among the world’s highest and more

‘than double the rates typical in Latin America One might think that rapid

‘economic growth is the natural result of such rates, but causality could go in the opposite direction The real engine of growth functions through the _movement of labour into the most efficient sectors, which have lower intensities

of capital use than do the state companies and to a large extent finance their investments through external savings, ie from foreign investment

‘members The growing numbers of business associations have also begun to play a similar role, supported by business people's conviction that they can influence official decisions (Dickson, 2003)

32

sblz Hand of Chủ

‘Common Weaknesses of China and Latin America

With its growing economic weight in the world, its high saving and investment ratios and its prodigious industrial capacity, China can seem like

a developed country Yet it remains an economy with low economic, social and institutional development and as such shares a series of weaknesses with, Latin American countries As economic development progresses, these weaknesses may become more troubling Some observers even talk of an eventual “Latin Americanisation of China: the possibility that growing income inequalities and an ill-regulated rush to privatise could precipitate economic and political upheaval” (The Economist, 25 March 2006)

Limited and Unequal Education

The Chinese and Latin American labour forces currently have similar levels of education, alittle less than six years on average, according to the well known Barro and Lee (2000) database China has made rather more rapid progress than Latin America, but both regions have lagged behind the East [Asian tigers and remain far below the average education level (ten years) of developed countries As in Latin America, considerable regional inequalities

‘mark education in China For example, enrolment rates in junior secondary education vary from 49 per cent in Tibet and about 60-70 per cent in seven other lagging provinces to about 99 per cent in Beijing, Shanghai, Tianjin and Zhejiang, In the lagging provinces only 70 per cent of the students complete

‘the nine-year compulsory education curriculum, compared with 100 per cent

in East China (World Bank, 2003a)* Many rural schools lack funds and must survive with fee donations from parents, a practice that the government hopes

to eradicate by the end of 2007 Absenteeism and early school dropout are frequent despite the compulsory nine years of study

As in Latin America, the improvement of education at low and middle levels is constrained on the supply side by limitations on resources and glaring, organisational deficiencies and on the demand side by a lack of economic incentives to encourage families to keep their children in school The emergence

‘of economic opportunities, however, has raised the return on education, especially at the highest educational levels, again as in Latin America, For example, the gap between the returns on university and primary education rose from 25 per cent in the late 1980s to almost 80 per cent in the late 1990s {World Bank, 20034) Income concentration has reflected these changes The

ISON: 8788204027081

Gini coefficient of income per capita increased from 0.35 in 1989 to 0.44 in

2004 (World Bank, 20004), and to nearly 0.5 in 2005 according to some sources”, not far from Latin America’s average coefficient of 0.53 (De Ferranti etal, 2003) Another common feature of education structures in China and Latin

‘America is the concentration of public expenditure at the tertiary level In contrast with the United States or South Korea, where public spending per student is less at the tertiary than at the secondary level, Mexico and Chile spend more than twice as much on a university student than a secondary student InChina the gap is 5:1 (De Ferranti ta, 2003) This reflects the priority

‘that the government gives to higher education in.a bid to speed up the county's technological progress in 2004, China had 13.3 million university students,

up from 5.6 million in 2000, engineering and management being the two most popular courses China had 820 000 students in postgraduate programs (up from 301 000 in 2000), as well as 115 000 students studying abroad (EIU, 2006), Since nothing comparable is happening in Latin America, the education structures of the two regions seem likely to diverge

Corruption and Weak Rule of Law

If anything is important for development, institutions and particularly respect for the law and control of corruption predominate (Easterly and Levine, 2002; Rodrik et al., 2002; Dollar and Kraay, 2002) According to

‘Kaufmann etal (2003), respect for the rule of law in China falls well below the

‘world average It is ona level similar to those of El Salvador or the Dominican Republic and significantly below those of Chile, Costa Rica and Uruguay (Figure 1.3) This measure of the rule of law synthesises various indicators and expert opinions that reflect the degree of respect for rules, contracts, legal security and property, as well asthe backing of the judicial system, On control

of corruption China ranks even lower, ona level with the Dominican Republic, Jamaica and Honduras and substantially below Chile, Costa Rica and Uruguay (Figure 1.4) In this system of indicators, corruption means the unlawful appropriation of public resources for private purposes

Although the rule of law is almost as weak in China as in the average Latin American country, the problem manifests itself with appreciable Aifferences In Latin America the homicide rate in the average country is 13 per 100.000 people; in China itis only 2.2 (IDB, 2000; Interpol, 2004) China also has low rates of other forms of violence and anti-social behaviour, such as robbery or sexual crime, which traditionally have been strongly punished In

The Visible Hand of China in Lata America Scene

igure 13 Rae of Law, 2005

Bativa Hamduns

°

e

°

° Peru ° Nicaragua ° Clore ° Argentina ° Ealador ° Guatemala) @ Ponguay | @ Veneseeh | -@

š Ê 0 & & z Sea Distance in standard devitions with respect to world average

Dts represen con vais an ines 95% confidence snes fr cach county, based on a wide Source: Kaufmann, Danie, Aatt Kraay and Massimo Marui (200) “Governance Matter Governance nities for 19862002" Weld Bank Ply Research Department Nesking Paper

34

Ítqiuissiu ‘Should Latin America Fear Chia?

Figure 14 Control of Corruption, 2005 cite

Cots Rica

Uruguay

Trinidad and Tobago

Panama Brae

— Mexico Nicaragua Peru rlSshader

LAngenima Dominican Republic

Chine Jamaica Honduras Guatemala

Bansdor Bota Venonga

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Sea Distance im standard evitons) with repost to world average

Dots represent central als and ines 9% confence intervals or ech county bss on việc

Source: Kautmann, Daniel, Aa Kraay and Massimo Mastrural 200), “Governance Mates Govermane indicate for 1996 202" xi Bạn Tuy Recasrh Deparment Working Foper:

tina in

CChina the weak rule of law becomes much more evident in the lack of secure property rights, especially in rural areas, the weakness of contracts and the unpredictability of judicial decisions,

Although the judicial systems of both China and Latin America suffer from serious weaknesses, these deficiencies have radically different origins,

In Latin America, justice operates with complex and formalistic procedures derived from the Napoleonic Code that delay decisions, lessen their transparency and limit access to the courts, Because ofthis legalistic tradition, lawyers are numerous and play an important role in economic activities China,

‘onthe other hand, has no tradition ofthis kind During the Mao Zedong period the law remained subordinate to political ideology, and the judicial system hardly existed, although national and local authorities controlled summary judicial mechanisms and mediation systems

Since 1978, a body of laws has been created by transplant from abroad

«with little adaptation, and an incipient legal tradition has slowly begun to emerge In 1985, there were only 13 403 qualified lawyers in all of China, and half of them worked only parttime By 2000, the number had risen to 117 260,

‘mainly full-time Nonetheless, it is mistaken to think that the rule of law will prevail as a direct result of the number of lawyers, courts and cases settled, Except in some ofthe large coastal cities, most of the more than 200 000 judges

in China are retired officials of the People’s Liberation Army who lack legal

‘raining and independence, Even more serious, the incipient legal system seems, alien to Chinese cultural tradition As one report has noted, “In many respects,

it is like a transplant or graft that isin danger of being rejected by the many natural antibodies it encounters.” (OECD, 2003, p 113)

In both China and Latin America, legal gaps and the lack of consistency and credibility of judicial decisions militate against a broad-based system of innovation Protection of intellectual property rights is weak and ineffectual Even so, China has made substantial progress in the last 20 years by setting

up specialised courts to deal with property rights, and a patent registration, system has gained credibility, as reflected in the growth of applications (over

170 000 in 2000) Like Latin America, however, China has not yet assimilated

2 culture of respect for international intellectual property, while the rules for the protection of patents, trademarks and commercial rights are imprecise and of limited effect (OECD, 2003)

A judicial system such as China's is hardly immune to corruption More generally, however, the problem of corruption in China stems from the

‘omnipresence of the state in its attempt to control economic decisions to preserve the power of the Communist Party The reform process initiated in

the late 1970s has prompted continuous conflict between the need to create new spaces for decision making by economic agents to improve efficiency and the expansion of potential sources of illegal income in the effort to maintain state control over other spaces The land-ownership control system still in force provides a good example Corruption originates in two simple facts: all land is owned by the state, and administrative decision determines the value

of rights of use As a result, access to land is difficult without illegal payments

to the district or municipal officials who control rights of use A press source reported that 84 per cent of sales of land rights in Shanghai in recent years occurred through illegal mechanisms (China Economic Quarterly, 2003) Other recognised areas of corruption are residence permits, customs and banks A striking and especially problematic feature of corruption in China lies in its

‘growing decentralisation asa result of the erosion of central state control over sub-national entities and their officials in the wake of the growth and diversification of private economic activity”

‘great strengths relative to Latin America, deriving from the size of itseconomy, the macroeconomic stability that it has enjoyed so far, the abundance of low- cost labour, the rapid expansion ofits transport, electricity and communications infrastructure and its ability to innovate Yet China also has weaknesses, Their principal source li inthe lack of separation between market and state, which explains the inefficiency of China's state enterprises, the deficiencies of its corporate norms and the fragility of its enormous financial system (the economy's high level of savings notwithstanding) In several ways the Chinese economy does not differ substantially from that of the typical Latin American country The rule of law is weak and corruption is endemic Education is poor and very poorly distributed, despite important scientific and technical

‘advances at the university level, The lack of respect for property rights, the difficulty of starting businesses and the norms and practices that inhibit

‘competition all conspire against innovation Thus public institutions will be the battlefield in the attempt by both regions o altract foreign direct investment and create environments conducive to private initiative